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Submitted to: Professor M.J. Rinaldi Submitted by: Roy Garin
Monday, November 27 2006 th
The European Central Bank and Its single Monetary Policy
Ever since it’s beginning the European Union, also known before as the European Steel and Coal Community was created only for one purpose. This purpose is for the economic stability of the European continents as well as for growth. In 1952 Robert Schuman and Jean Monnet offered a plan that enabled six countries to participate in the community; countries were: France, West Germany, Luxembourg, Belgium, Italy and the Netherlands. The main reason for this event was to prevent future wars. Ever since the Creation of the ECSC, there have been many other important treaties resulting in what today we call the EU (European Union). In 1967, because of the achievement of the ECSC, the same 6 nations decided to improve the community and by doing so agreed to remove trade barriers resulting in a common market, creating an atomic energy community as well as changing the ECSC name to EEC which stands for the European Economic Community (EEC). (Europa). In 1992, after the treaty of Maastricht, the common market was turned into a single market were it was much more easier to trade inside the community. It is also important to realize that the European Union Today involves 25 member states excluding a couple of other states that are joining in January
2007. Nowadays the ECB bases its operations out of Frankfurt, Germany and monitors the Euro currency for the existing 12 members and evaluates the economic potential of future members. In order to understand the economic growth of the European union today, it is crucial to recognize why and how it became so popular to join the Union of Europe and how the European Central Bank (ECB) and its policies which are making Europe a better place to live in with an increasing employment rate. It has been just 50 years and Europe is now the second biggest economy in the world. The goal of the Union is not only to create growth and peace but also rather to improve social living and much better working conditions and the fact of having a single currency and with the removal of barriers, today Europe can achieve its goals with help of technology and progress.
ECB History The ECB was established on June 1st 1998 when 11 participating Member States appointed the President, the Vice-President and the four other members of the Executive Board of the ECB. Before the establishment of the ECB, there were several steps that needed to be completed by the European Monetary Union (EMU). Those steps were the same ones that the fathers (Schumann and Monnet) of the EU were fighting for in 1957, at the treaty of Rome.
“ A central bank's actions to influence the availability and cost of
money and credit, as a means of helping to promote national economic goals. Tools of monetary policy include open market operations, discount policy and reserve requirements.” (Google Definition).
European Monetary Union The European Monetary Union is the council that supervises the European monetary institute. A total, there were 3 attempts to create the EMU, but none of the 2 first ones seemed to work because the economies of the other nations weren’t ready for it in terms of the EEC blocking their way with policies and regulations. During the first attempt to create the EMU there was the problem with the nonconvertibility of US dollars into Gold and the rising oil prices. On the second attempt, which has failed, there were problems with the exchange rate, which would have had a negative economic impact on the member states.
The successful EMU was first put on paper as proposal in 1988 by Jacque Delors who proposed the creation of the Economic and Monetary Union purposed on creating a single currency in order to avoid many economic obstacles as well as to prevent wars. That single currency proposed by Delors was known as the Single European Act. (ECB) In order to create a concrete ground for that Union, 3 stages were engineered to create the
Stage 1: Stage one of was basically to remove any laws that involved the movement of capital between member states. This stage was to be taken action as of July 1990. Other plans for that stage were: • • • Increased cooperations between central Banks The Free Use of the European Currency Unit Improvement of Economic Convergence
Stage 2: This stage, which was taken in 1994, was even more important than the above stated one. The second stage was able to begin only because of the EMI (European Monetary Institute). The Purpose of EMI was to: • • Tight relationship between European central Banks Meet all the requirements needed for the creation of the ESCB (European System of Central Banks) • • Control of the Single Currency Policy Acknowledging Delors proposition and preparing for the creation of a single
A very important role for the EMI at the time was to adopt the ERM II, which was needed. The ERM, which represents European Rate mechanism, not to be mistaken for the first ERM, was a successful one. The second stage is also the one were the decision to create banknotes for the European currency took effect; currency which will be called the euro. (ECB)
By May 1998, the European council has decided to appoint 11 member states which have fulfilled the requirements for stage 2, resulting in proceeding to stage 3. Those member states have been appointed to the executive levels of the ECB.
Stage 3: This was the final stage in which the ECB gained control of the 11 member states’ currency that was admissible by the EMU. Final stage of the EMU included also(ECB): • • • • • Irrevocable fixing of the Exchange Rates Introduction of the Euro Conduct of the single European policy by the European System of Central Banks Entry of the ERM II role Entry into force of the Stability Growth Rate
The Role of the ECB Growth and Prosperity are the main advantages that the Euro currency has given to the countries using it and as well for the ones who will use it soon. All of those previously mentioned above advantages because they make the Union more attractive in terms of competition and social as well as economical well being. Although some of the European Union members have not fully joined the EU in terms of currency, the process has been quite beneficial. The main reason for the creation of the ECB and ESCB is to maintain price stability but there are other objectives that the ECB has to maintain in order to obtain harmonization of the process. The ECB has to maintain the monetary policy. Today, to fulfill the task, the ECB has to keep the inflation rate around or below 2% over the medium term. In order to maintain that 2% it must maneuver the shortterm interest rate which also needs to revolve around that same 2%. This is important because of the fact that Europe’s main industry within its member states’ borders is agriculture, which represents a big part of the EU budget. In order to control the inflation and as well as the currency, the ECB needs to be a close watcher to direct the new member states with the right economic growth and stability, which means that the ECB will keep the rate of inflation between an inflation period and a deflation one to balance the exchange rate. The ECB has also controls the currency reserve and has the power to buy and sell foreign exchange on the international currency market even though the ECB’s policy does not
concentrate on international exchanges but rather on inflation. “Another important role for the ECB is the conduct of the foreign exchange operations, which basically includes the foreign exchange interventions as well as in the case of the sale of foreign currency interest income or commercial transactions.” (ECB).
ECB and the Federal Reserve
The main difference between the Federal Reserve and the ECB are in terms of monetary policies: FRB • The Federal Reserve controls the open market operations of the United states which means that this policy controls the purchase of governmental securities such as the U.S. Treasury and the federal agency securities, which are the main technique that the FRB uses for applying monetary policies, with a supervision of the FOMC (The Federal Open Market Committee). (FRB) • The Discount Rate that manages the interest rate that commercial banks and other depository institutions on loans receive from their regional Federal reserve banks all across the U.S. that charge to those institutions is also called the discount window of the FRB which offers 3 types of discount window that each have different interest rates; primary credit (6.25%), secondary credit (6.75%) and
seasonal credits (5.30%).(FRB) • The FRB holds 8 meetings per year
ECB The ECB must objectively concentrate mostly on price stability on the Euro and the Eurosystem: • The ECB has other roles besides the price stability but the price stability issue is the main task that the ECB has for the moment and can override any other role. • The ECB has power over the single monetary policy, which it needs to control and use over inflation and deflation periods based on the period. • The ECB uses the Twopillar approach to make decisions in order to obtain price stability on a yeartoyear basis. • The council of Governors meet twice a month in order to analyze and make decisions on the current situation during that certain period
The “Economic Integration Process” The idea behind the European integration was and still is the Economic integration which would be sort of a long project to create an European harmony for people in terms of Social, Political, Environmental and Economical reasons.
This process could be described as the movement into the future by removing every obstacle in the way of creating that harmonization. In order to remove those obstacles left, Europe has created a blueprint of the Economic Integration process by putting forward a set of Criteria, which were accepted to obey in 1992 called the Maastricht criteria, which are:
Price stability: the inflation rate should be no more than 1.5 percentage points above the rate for the three member states with the best inflation rate over the previous year;
The budget deficit (the gap between governments’ revenue and expenditure): this must generally be below 3% of gross domestic product (GDP);
Debt: the limit was set at 60% of GDP, but a country with a higher debt-to-GDP ratio can nevertheless adopt the euro if its debt levels are falling steadily;
The long-term interest rate: this should not be more than two percentage points above the rate in the three member states with the best inflation rate over the previous year;
Exchange rate stability: the exchange rate should have stayed within pre-defined fluctuation margins for two years. These margins are those of the European exchange rate mechanism, an optional system for member states, which want to link their currency to the euro. (Slides)
Ever since the idea of a European central bank emerged, the European union has gone from a continent that was once ongoing many wars to a better and more developed economy that is still growing. With Delors idea to form a single monetary policy, Europe has become one of most vibrant economy of the world. Although the process was long, nowadays the EU has reached its long run goal and has already started the movement towards the future by inviting other countries to its Union. The Union will face challenges that it will have to monitor and control with a close eye because of the Eastern countries which are somehow viewed in the west as both n advantage and a disadvantage because of their uncertainty in economic stability. Essentially cautiously managed the ECB can steer a collective European economy, east and west, forward affectively into the 21st century.
Bibliography 1) The European Central Bank (ECB), Retrieved on Monday November 20th 2006, Retrieved from: www.ecb.int 2) Europa, Retrieved on Monday November 20th 2006 Retrieved from: www.europa.edu 3) Federal Reserve Board (FRB). Retrieved on Sunday, November 26, 2006. Retrieved from: www.federalreserve.com 4) ERM II, Financial Dictionary. Retrieved on Sunday, November 26, 2006. Retrieved from:
5) ERM II, Glossary of Statistical Forms. Retrieved on Sunday, November 26, 2006. Retrieved from:
http://stats.oecd.org/glossary/detail.asp?ID=3055 6) Google Definition of Monetary Policy. Retrieved on Sunday, November 26, 2006. Retrieved from: http://www.google.com/search?hl=en&lr=&defl=en&q=defi ne:Monetary+Policy&sa=X&oi=glossary_definition&ct=title
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